10-Q 1 gran-q2.txt BODY OF FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For quarterly period ended June 30, 2002 Commission File No. 0-14895 Granite State Bankshares, Inc. (Exact name of registrant as specified in its charter) New Hampshire 02-0399222 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 122 West Street, Keene, New Hampshire 03431 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (603) 352-1600 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ( X ) No ( ) The number of shares outstanding of each of the issuer's classes of common stock, as of August 5, 2002 was 5,190,253, $1.00 par value per share. INDEX Granite State Bankshares, Inc. and Subsidiary Part I Financial Information Page Item 1. Financial Statements: Consolidated Statements of Financial Condition June 30, 2002 and December 31, 2001 3 Consolidated Statements of Earnings Three and Six Months Ended June 30, 2002 and 2001 4 Consolidated Statements of Comprehensive Income Three and Six Months Ended June 30, 2002 and 2001 5 Consolidated Statements of Cash Flows Three and Six Months Ended June 30, 2002 and 2001 6 Notes to Unaudited Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 Part II Other Information Item 1. Legal Proceedings 23 Item 2. Changes in Securities 23 Item 3. Defaults upon Senior Securities 23 Item 4. Submission of Matters to a Vote of Security Holders 23 Item 5. Other Information 24 Item 6. Exhibits and Reports on Form 8-K 24 Signatures 25 2 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Financial Condition

See accompanying notes to unaudited consolidated financial statements. 3 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Earnings

See accompanying notes to unaudited consolidated financial statements. 4 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Comprehensive Income

See accompanying notes to unaudited consolidated financial statements. 5 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1 - Financial Statements Consolidated Statements of Cash Flows

See accompanying notes to unaudited consolidated financial statements. 6 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 1. Financial Statements Notes to Unaudited Consolidated Financial Statements June 30, 2002 Note 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the current fiscal year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2001. Note 2. Acquisition of Insurance Agencies On February 8, 2002, the Company's subsidiary bank, Granite Bank, reached agreements to acquire Blake Insurance Agency, Sise Insurance and Sise Financial Services, all located in Portsmouth, New Hampshire. At the time of the acquisition, the combined agencies had annual premium volume of approximately $23,000,000. The combined agencies revenues are represented by commission income, which is based upon percentages of premium volume billed. Effective April 1, 2002, the Company completed the acquisitions of these three insurance agencies. The acquisitions were accounted for using the purchase method of accounting and results of operations relating to the acquired insurance agencies are reflected in earnings commencing April 1, 2002. The total purchase price for the three insurance agencies including transaction costs of approximately $100,000 was approximately $4,800,000 and included payments of approximately $4,500,000 in cash and the issuance out of treasury of 11,259 shares of Company common stock. The acquisition was allocated as follows:

The total consideration for the acquisition included cash paid net of cash acquired of $4,165,000 and the issuance out of treasury of 11,259 shares of Granite State Bankshares, Inc. common stock. The agency customer renewal lists are being amortized on the straight line method over ten years. 7 Note 3. Earnings Per Share Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Information regarding the computation of earnings per share is as follows:

Note 4. Securities Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost; debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in earnings; and debt and equity securities not classified as either held-to-maturity or trading are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as part of accumulated other comprehensive income (loss), net of related income tax effects. At June 30, 2002 and December 31, 2001, the Company had no securities classified as trading securities. 8 The amortized cost, estimated market value and carrying value of securities at June 30, 2002 and December 31, 2001 were as follows:

At June 30, 2002, all of the U.S. Government Agency Obligations with carrying values of $187,799,000 were callable at the discretion of the issuers without penalty, of which $44,128,000 were callable during the remainder of 2002 at a weighted average yield of 4.55%, $135,359,000 were callable during 2003 at a weighted average yield of 4.90% and $8,312,000 were callable during 2004 at a weighted average yield of 5.89%. 9 Note 5. Loans Loans consist of the following at:

Real estate mortgage loans and other loans are stated at the amount of unpaid principal, less unearned income and the allowance for possible loan losses. Interest on loans is accrued and credited to operations based upon the principal amount outstanding. When management determines that significant doubt exists as to collectibility of principal or interest on a loan, the loan is placed on nonaccrual status. In addition, loans past due 90 days or more as to principal or interest are placed on nonaccrual status, except those loans which, in management's judgment, are fully secured and in the process of collection. Interest accrued but not received on loans placed on nonaccrual status is reversed and charged against current operations. Interest subsequently received on nonaccrual loans is either applied against principal or recorded as income according to management's judgment as to the collectibility of principal. Loans considered to be uncollectible are charged against the allowance for possible loan losses. The allowance is increased by charges to current operations in amounts sufficient to maintain the adequacy of the allowance. The adequacy of the allowance is determined by management's evaluation of the extent of losses inherent in the loan portfolio and prevailing economic conditions. 10 Changes in the allowance for possible loan losses are as follows:

Information with respect to impaired loans consisted of the following at:

The Company's policy for interest income recognition on impaired loans is to recognize income on impaired loans on the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company; if these factors do not exist, the Company will not recognize income. The average recorded investment in impaired loans was $2,610,000 and 1,960,000 for the six months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002 and 2001, the Company recognized no income on impaired loans. Note 6. Interest Bearing Deposits Interest bearing deposits consist of the following at:

11 Note 7. Supplemental Disclosures of Cash Flow Information

Note 8. Stock Repurchase Program On March 12, 2002, the Company announced a Stock Repurchase Program ("Program"), whereby the Company's Board of Directors authorized the repurchase of up to 10% (or approximately 516,000 shares), of the Company's outstanding common shares from time to time. Shares repurchased under this Program may be held in treasury, retired, or used for general corporate purposes. As of June 30, 2002, the Company had repurchased no shares under this Program. The repurchase of shares under a previous stock repurchase program was completed in March 2002. Note 9. Adoption of Accounting Policies The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, on January 1, 2001 as required by the Financial Accounting Standards Board ("FASB"). The cumulative effect on prior years of adopting SFAS No. 133 on January 1, 2001, was not significant and therefore has not been separately disclosed. The impact of accounting for derivative instruments under SFAS No. 133 during the six months ended June 30, 2001 decreased net interest and dividend income by $163,000 and net earnings by $98,000, or $.02 per basic and diluted share. There was no significant impact on net earnings or earnings per share of accounting for derivative instruments under SFAS No. 133 during the three months ended June 30, 2001 and the three and six months ended June 30, 2002. On July 20, 2001, the FASB issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". SFAS No. 141 is effective for all business combinations initiated after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS No. 142. Major provisions of these Statements and their effective dates for the Company are as follows: * All business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interests method of accounting is prohibited except for transactions initiated before July 1, 2001. * Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability. * Goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, will not be amortized. Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. * Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator. 12 * All acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting. The Company completed a transitional fair value based impairment test of goodwill as of January 1, 2002. No impairment of goodwill was evident as a result of the impairment testing performed. The Company adopted SFAS No. 142 prospectively on January 1, 2002. The following table presents reported net earnings and earnings per share data for the three and six months ended June 30, 2002 and 2001, as well as pro forma adjustments relating to the three and six months ended June 30, 2001, as if SFAS No. 142 had been adopted on January 1, 2001.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which statement is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years, with earlier application encouraged and its provisions are to be applied prospectively. The adoption of this statement on January 1, 2002 had no impact on the Company's consolidated financial statements. 13 Granite State Bankshares, Inc. and Subsidiary Part I - Financial Information Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations June 30, 2002 General All information within this section should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Form 10-Q. All references in the discussion to financial condition and results of operations are to the consolidated financial position of the Company and its subsidiary taken as a whole. The principal business of the Company is to serve as a financial intermediary attracting deposits from the general public and making both secured and unsecured loans. The operating results of the Company depend primarily on net interest and dividend income earned by the Company's subsidiary, Granite Bank ("the subsidiary bank"). Net interest and dividend income is the difference between interest and dividend income on interest earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, which consist of deposits and borrowings. Operating results of the Company also depend upon the provision for possible loan losses, noninterest income, noninterest expense and income taxes. Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which the company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset-liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Financial Condition Total assets increased by $64,971,000 or 6.38%, from $1,018,942,000 at December 31, 2001 to $1,083,913,000 at June 30, 2002. The increase in assets resulted primarily from increases in cash and due from banks, interest bearing deposits in other banks, securities available for sale, portfolio loans and other assets, partially offset by a decrease in loans held for sale. Cash and due from banks increased $2,990,000, from $21,142,000 at December 31, 2001 to $24,132,000 at June 30, 2002. The increase related primarily to an increase in the amount of items processed through the Company's depository bank accounts that settled subsequent to the end of the reporting period. Interest bearing deposits in other banks, which primarily consist of deposits with the Federal Home Loan Bank of Boston, increased $38,120,000, from $4,530,000 at December 31, 2001 to $42,650,000 at June 30, 2002. Interest bearing deposits in other banks are short-term overnight investments and the level of the Company's investment in these instruments fluctuates as investments are made in other interest earning assets such as loans, 14 securities held to maturity and securities available for sale, and as balances of interest bearing liabilities such as deposits, securities sold under agreements to repurchase and other borrowings fluctuate. These instruments are also used to fund cash and due from bank requirements. Securities available for sale increased $25,497,000, from $274,201,000 at December 31, 2001 to $299,698,000 at June 30, 2002. The increase in securities available for sale were funded by a decrease in loans held for sale and increases in deposits and other borrowings. Included in securities available for sale at June 30, 2002, are U.S. Government Agency Obligations with carrying values of $187,799,000, callable at the discretion of the issuers without penalty, of which $44,128,000 are callable during the remainder of 2002 at a weighted average yield of 4.55%, $135,359,000 are callable during 2003 at a weighted average yield of 4.90% and $8,312,000 are callable during 2004 at a weighted average yield of 5.89%. Should the issuers call these obligations, the yields available on similar replacement securities are likely to be lower. Loans held for sale decreased $9,271,000, from $14,821,000 at December 31, 2001 to $5,550,000 at June 30, 2002. The decrease in loans held for sale is the result of sales of loans originated for sale exceeding the origination of loans held for sale. This decrease is primarily related to the timing of loan closing commitments and the high levels of mortgage refinance activity that culminated in the latter part of 2001. As a result of the significant loan refinance activity during the latter half of 2001 and the first quarter of 2002, management does not expect to originate the same level of loans for sale in the secondary mortgage market during the remainder of 2002 as compared to the same periods in 2001, or to realize the same level of gains on the sales of those loans during the last six months of 2002 as were realized in the last six months of 2001 or the first six months of 2002. Net loans were relatively stable, increasing just $2,338,000, or 0.36% from $645,840,000 at December 31, 2001, to $648,178,000 at June 30, 2002. Growth in construction and land development loans, home equity loans, commercial real estate loans and multifamily real estate loans, which was spurred by the low interest rate environment, was partially offset by decreases in residential real estate loans and commercial, financial and agricultural loans. The decrease in residential real estate loans of $10,071,000, or 3.00%, was primarily the result of the lower interest rate environment that was prevalent during 2001 and 2002, which encouraged these borrowers to refinance into fixed rate loan products, which the Company sells into the secondary mortgage market. Total deposits increased $46,179,000, or 6.47%, from $714,143,000 at December 31, 2001 to $760,322,000 at June 30, 2002. The significant changes in deposits related to increases in NOW accounts, demand deposits and savings accounts of $28,492,000, $23,457,000 and $6,406,000, respectively, partially offset by decreases in time certificates of $13,014,000. The increase in NOW and demand deposit accounts relates primarily to the success the Company has had in targeting these accounts as growth accounts. The decrease in the time certificates related partially to depositors looking to achieve higher yields by investing their funds in alternate investment products. Additionally, as a result of the current low interest rate environment, depositors have maintained their funds in short term deposits, which contributed to the increase in NOW and savings accounts and the decrease in time certificates. Securities sold under agreements to repurchase decreased $6,702,000, from $85,013,000 at December 31, 2001 to $78,311,000 at June 30, 2002. Such accounts usually reach a peak in June and December as municipalities invest the real estate taxes they collect and decrease after those periods as the municipalities use their invested cash. Other borrowings, which consist primarily of borrowings from the Federal Home Loan Bank of Boston ("FHLB"), increased $19,985,000 to $155,449,000 at June 30, 2002 from $135,464,000 at December 31, 2001. Changes in other borrowings include additional borrowings in the form of an FHLB callable advance of $20,000,000 at an interest rate of 3.95% per annum, with a maturity date of January 17, 2012, which is callable at the option of the FHLB beginning January 14, 2005. Stockholders' equity increased by $5,364,000 from $80,537,000 at December 31, 2001 to $85,901,000 at June 30, 2002. The increase relates primarily to net earnings of $7,057,000 and an increase of $1,539,000 for the change in accumulated other comprehensive income, partially offset by decreases of $1,996,000 for the purchase of treasury stock and $1,963,000 for dividends declared. 15 Results of Operations Net Earnings Net earnings for the three and six months ended June 30, 2002 were $3,721,000 and $7,057,000 compared to $2,730,000 and $5,387,000 for the three and six months ended June 30, 2001. Basic earnings per share were $.73 and $1.37 for the three and six months ended June 30, 2002, compared to $.52 and $1.02 for the three and six months ended June 30, 2001. Diluted earnings per share were $.70 and $1.33 for the three and six months ended June 30, 2002 compared to $.50 and $.99 for the three and six months ended June 30, 2001. The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, on January 1, 2001 as required by the Financial Accounting Standards Board ("FASB"). The cumulative effect on prior years of adopting SFAS No. 133 on January 1, 2001, was not significant and therefore has not been separately disclosed. The impact of accounting for derivative instruments under SFAS No. 133 during the six months ended June 30, 2001 decreased net interest and dividend income by $163,000 and net earnings by $98,000, or $.02 per basic and diluted share. There was no significant impact on net earnings or earnings per share of accounting for derivative instruments under SFAS No. 133 during the three months ended June 30, 2001 and the three and six months ended June 30, 2002. The Company adopted SFAS No. 142, " Goodwill and Intangible Assets", prospectively on January 1, 2002. The Company completed a transitional fair value based impairment test of goodwill as of January 1, 2002. No impairment of goodwill was evident as a result of the impairment testing performed. As a result of the adoption of SFAS No. 142 on January 1, 2002, amortization of goodwill ceased. Had SFAS No. 142 been adopted on January 1, 2001, amortization of goodwill totaling $117,000 and $234,000 for the three and six months ended June 30, 2001, would not have been recognized. On an after tax basis this would have increased net earnings by $83,000 to $2,813,000 for the three months ended June 30, 2001 and increased net earnings by $166,000 to $5,553,000 for the six months ended June 30, 2001. The impact on basic earnings per share for the three and six months ended June 30, 2001 would have been to increase reported earnings per share from $.52 and $1.02, respectively, to $.53 and $1.05, respectively, while the impact on diluted earnings per share for the three and six months ended June 30, 2001 would have been to increase reported earnings per share from $.50 and $.99, respectively, to $.52 and $1.02, respectively. For further information refer to note 9 of Notes to Unaudited Consolidated Financial Statements. Interest and Dividend Income Interest and dividend income for the three and six months ended June 30, 2002 was $16,034,000 and $32,204,000 compared to $17,357,000 and $34,461,000 for the corresponding periods in 2001. The decrease in interest and dividend income for the three and six months ended June 30, 2002 compared to the three and six months ended June 30, 2001 is primarily attributable to a decrease in the overall yield on interest earning assets to 6.46% and 6.57% for the three and six months ended June 30, 2002 compared to 7.62% and 7.72% for the same periods in 2001, partially offset by an increase in the average balance of interest earning assets of $82,960,000 and $88,587,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001. The decrease in overall yield on interest earning assets is attributable to the Federal Reserve Board easing interest rates eleven times, totaling 475 basis points, during 2001 as well as a change in the mix of assets from loans to lower yielding securities and interest earning investments, for the three and six months ended June 30, 2002 as compared to the same periods a year ago. The lower interest rate environment during the first and second quarters of 2002 as compared to the same periods in 2001 resulted in a decrease in the yield on loans to 7.18% and 7.29% for the three and six months ended June 30, 2002 compared to 8.16% and 8.23% for the three and six months ended June 30, 2001 and a decrease in the yield on securities and interest earning investments from 6.20% and 6.32% for the three and six months ended June 30, 2001 to 5.09% and 5.16% for the three and six months ended June 30, 2002. Interest Expense Interest expense for the three and six months ended June 30, 2002 was $6,015,000 and $12,212,000 compared to $8,341,000 and $16,839,000 for the corresponding periods in 2001. The decrease in interest expense 16 for the three and six months ended June 30, 2002 compared to the same periods in 2001 is primarily due a decrease in the cost of interest bearing liabilities to 2.75% and 2.82% for the three and six months ended June 30, 2002 compared to 4.14% and 4.26% for the same periods a year earlier, partially offset by an increase in the average balance of total interest bearing liabilities of $68,777,000 and $74,194,000 for the three and six months ended June 30, 2002 compared to the same periods a year earlier. Average balances of savings deposits increased $58,958,000 and $52,447,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001. Average balances of time deposits decreased $21,750,000 and $15,570,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001. The average cost of savings deposits decreased to 1.43% for the three and six months ended June 30, 2002 compared to 2.28% and 2.35% for the three and six months ended June 30, 2001. The decrease in the average cost of savings deposits was primarily related to the lower short term interest rates in 2002 compared to 2001. The average cost of time deposits decreased from 5.88% and 5.95% for the three and six months ended June 30, 2001 to 3.61% and 3.78% for the same periods in 2002. The decrease in the average cost of time deposits was primarily the result of time deposits maturing in 2001 and 2002 and generally being renewed at lower rates as a result of the lower interest rate environment during the latter part of 2001 and the first and second quarters of 2002. The average cost of securities sold under agreements to repurchase and other borrowed funds decreased to 3.98% for the three and six months ended June 30, 2002 compared to 4.74% and 5.00% for the three and six months ended June 30, 2001. The lower cost of securities sold under agreements to repurchase and other borrowed funds related primarily to the lower interest rate environment during 2002 compared to 2001, with average short term rates on securities sold under agreements to repurchase being lower in 2002 than 2001. Additionally, callable advances from the FHLB totaling $55,000,000 were borrowed during 2001 and 2002 at lower rates than previous advances, which also lowered the average cost of borrowings. The average balance of securities sold under agreements to repurchase and other borrowed funds increased $31,569,000 and $37,316,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001. Average balances of FHLB borrowings increased $31,233,000 and $37,808,000 while average balances of securities sold under agreements to repurchase increased by $336,000 and decreased by $492,000 during the three and six months ended June 30, 2002 compared to the same periods in 2001. Net Interest and Dividend Income Net interest and dividend income increased by $1,003,000 and $2,370,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001. The increase for the three and six months ended June 30, 2002 compared to the same periods in 2001 is primarily due to the changes in interest and dividend income and interest expense as discussed above. The interest rate spread increased from 3.48% and 3.47% for the three and six months ended June 30, 2001 to 3.71% and 3.75% for the three and six months ended June 30, 2002. The net yield on interest earning assets increased from 3.96% and 3.95% for the three and six months ended June 30, 2001 to 4.03% and 4.08% for the three and six months ended June 30, 2002. The interest rate spread and net yield on interest earning assets decreased during the three months ended June 30, 2002, compared to the three months ended March 31, 2002. Based upon the current levels of interest earning assets and interest bearing liabilities and the current interest rate environment, management does not expect the interest rate spread or the net yield on interest earning assets to increase, and they may in fact decrease during the remaining quarters of 2002. Provision for Possible Loan Losses The provision for possible loan losses for the three and six months ended June 30, 2002 was $100,000 and $325,000, compared to $120,000 and $180,000 for the three and six months ended June 30, 2001. The decrease for the three months ended June 30, 2002, is primarily related to a smaller increase in nonperforming loans for the three months ended June 30, 2002 compared to the same period in 2001, partially offset by higher commercial and other loan growth in 2002 compared to the same period in 2001. The increase for the six months ended June 30, 2002, is primarily related to additional provisions related to two nonperforming commercial real estate loans and an increase in net charge offs, partially offset by the settlement of one nonperforming commercial real estate loan. The allowance for possible loan losses is maintained through provisions for possible loan losses based upon management's ongoing evaluation of the losses inherent in the loan portfolio. The methodology for determining the amount of the allowance for possible loan losses consists of several elements. Nonperforming, 17 impaired and delinquent loans are reviewed individually and the value of any underlying collateral is considered in determining estimates of losses associated with those loans. Another element involves estimating losses inherent in categories of loans, based primarily on historical experience, industry trends and trends in the real estate market and the current economic environment in the Company's primary market areas. The last element is based on management's evaluation of various conditions, and involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with this element include the following: industry and regional conditions and/or concentrations; seasoning of the loan portfolio and changes in the composition of and growth in the loan portfolio; the strength and duration of the current business cycle; existing general economic and business conditions in the lending areas; credit quality trends, including trends in nonperforming loans expected to result from existing conditions; and historical loan charge-off experience. Management uses currently available information in determining the adequacy of the allowance for possible loan losses. If economic conditions deteriorate, significant additional provisions for possible loan losses may be necessary. Noninterest Income Noninterest income for the three and six months ended June 30, 2002 totaled $3,283,000 and $5,450,000 compared to $1,770,000 and $3,392,000 for the same periods in 2001. The increase of $1,513,000 and $2,058,000 for the three and six months ended June 30, 2002 compared to the same periods in 2001, relates primarily to an increase of $709,000 in insurance agency commissions as a result of the acquisition of three insurance agencies which was completed on April 1, 2002, an increase in net gains on sales of securities available for sale of $352,000 and $74,000, respectively, and an increase in net gains on sales of loans of $216,000 and $893,000, respectively. The increase in net gains on sales of loans for 2002 relates to the lower interest rate environment, which encouraged residential borrowers to refinance into fixed rate loan products which the Company sells in the secondary mortgage market. Since the Company does not expect further significant reductions in market interest rates, management does not expect to realize the same level of gains on sales of loans in the secondary mortgage market during the last six months of 2002 as compared to the first six months of 2002 or the last six months of 2001. Other increases in noninterest income for the three and six months ended June 30, 2002 compared to the same periods in 2001 included $78,000 and $138,000, respectively, in commissions from brokerage activities, $39,000 and $81,000, respectively, in mortgage service fees and $10,000 and $44,000, respectively, in customer account fees and service charges. Noninterest Expense Noninterest expense for the three and six months ended June 30, 2002 increased $762,000 and $1,310,000 compared to the same periods a year earlier. The increase for the three and six months ended June 30, 2002, compared to the same periods in 2001, relates to increases in salaries and benefits expense and occupancy and equipment expense, partially offset by a decrease in other noninterest expense. The acquisition of three insurance agencies, which was completed on April 1, 2002, contributed to the increases in salaries and benefits expense and occupancy and equipment expense. Salaries and benefits expense increased by $735,000, to $4,223,000 for the three months ended June 30, 2002 as compared to $3,488,000 for the same period a year earlier and increased by $1,281,000, to $8,060,000 for the six months ended June 30, 2002 as compared to $6,779,000 for the same period a year earlier. The increase in salaries and benefits was attributable to the acquisition of the three insurance agencies which primarily contributed to an increase in full time equivalent employees from 302 at year end 2001 to 334 at June 30, 2002. Additionally, normal salary increases and an increase in commissions paid to mortgage loan originators as a result of the increased refinance activity for residential real estate loans, which occurred for the three and six months ended June 30, 2002 compared to the same periods in 2001, contributed to the increase. Occupancy and equipment expense increased by $234,000, to $1,292,000 for the three months ended June 30, 2002 as compared to $1,058,000 for the same period a year earlier and increased by $204,000, to $2,353,000 for the six months ended June 30, 2002 as compared to $2,149,000 for the same period a year earlier. The increase in occupancy and equipment expense is primarily attributable to occupancy costs associated with the acquired insurance agencies. Other expenses decreased by $207,000, to $1,665,000 for the three months ended June 30, 2002 as compared to $1,872,000 for the same period a year earlier and decreased by $175,000, to $3,293,000 for the six months ended June 30, 2002 as compared to $3,468,000 for the same period a year earlier. The decrease in 18 other expenses for the three and six months ended June 30, 2002 compared to the same periods in 2001, is partially attributable to a reduction in goodwill amortization of $117,000 and $234,000, respectively, decreases in professional fees of $67,000 and $54,000, respectively, decreases in other real estate owned expenses of $67,000 and $91,000, respectively, and decreases in advertising and marketing expenses of $43,000 and $76,000, respectively. These decreases were partially offset by increases in amortization expense on mortgage servicing rights of $64,000 and $128,000, respectively, and amortization of agency customer renewal lists relating to the insurance agency acquisitions of $75,000 and $75,000, respectively. Income Taxes Income tax expense for the three and six months ended June 30, 2002 was $2,301,000 and $4,354,000 compared with $1,518,000 and $3,051,000 for the same periods in 2001. Income tax expense as a percentage of earnings before income taxes was 38.21% and 38.16% for the three and six months ended June 30, 2002 and 35.73% and 36.16% for the three and six months ended June 30, 2001. The increase in the effective tax rate in 2002 relates primarily to a decrease in the dividend received deduction on marketable equity securities as a result of a decrease in investments in marketable equity securities in 2002 compared to 2001. Risk Elements Total nonperforming loans decreased from $3,015,000 or 0.46% of total loans, at December 31, 2001, to $2,275,000 or 0.35% of total loans, at June 30, 2002. The allowance for possible loan losses as a percent of total nonperforming loans was 356.22% at June 30, 2002, compared with 268.16% at December 31, 2001. As shown in the following table, nonperforming assets as a percentage of total assets were 0.21% and 0.30%, as of June 30, 2002 and December 31, 2001, respectively.

Liquidity The Company's primary sources of liquidity, through its subsidiary bank, are its borrowing capacity with the Federal Home Loan Bank of Boston, interest bearing deposits in other banks and securities available for sale, particularly short-term investments. At June 30, 2002, short-term and long- term borrowings from the Federal Home Loan Bank of Boston were $155,437,000, with an additional available borrowing capacity of approximately $92,780,000; interest bearing deposits in other banks were $42,650,000 and securities available for sale were $299,698,000. Included in securities held to maturity and securities available for sale are debt securities with a carrying value of $301,564,000. The weighted average maturity for debt securities held to maturity and available for sale, excluding mortgage- backed securities with a carrying value of $6,729,000, is approximately 66 months. 19 The weighted average interest rate sensitivity for these securities is approximately 44 months, when adjusting floating rate securities in the amount of $19,061,000 to their next repricing date from their maturity date. In addition to these liquidity sources, the Company has significant cash flow from the amortization of loans through its subsidiary bank. Capital Resources Under the Federal Reserve Board's guidelines, bank holding companies such as the Company currently are required to maintain a minimum ratio of qualifying total capital to total assets and off-balance sheet instruments, as adjusted to reflect their relative credit risks, of 8.0 percent. At least one-half of total capital must be comprised of common equity, retained earnings, non-cumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill ("Tier I capital"). The Federal Reserve Board also has established an additional capital adequacy guideline referred to as the Tier I leverage capital ratio, which measures the ratio of Tier I capital to total assets less goodwill. Although the most highly-rated bank holding companies will be required to maintain a minimum Tier I leverage capital ratio of 3.0 percent, most bank holding companies will be required to maintain Tier I leverage capital ratios of 4.0 percent to 5.0 percent or more. The actual required ratio will be based on the Federal Reserve Board's assessment of the individual bank holding company's asset quality, earnings performance, interest rate risk, and liquidity. The Company was in compliance with all regulatory capital requirements at June 30, 2002 and December 31, 2001. Substantially similar rules have been issued by the Federal Deposit Insurance Corporation ("FDIC"), with respect to state-chartered banks which are not members of the Federal Reserve System such as the subsidiary bank. At June 30, 2002 and December 31, 2001, the subsidiary bank was in compliance with all regulatory capital requirements. Additionally, at June 30, 2002, the subsidiary bank was considered "well capitalized" for purposes of the FDIC's prompt corrective action regulations. At June 30, 2002 the Company's and the subsidiary bank's regulatory capital ratios as a percentage of assets are as follows:

On March 12, 2002, the Company announced a Stock Repurchase Program ("Program"), whereby the Company's Board of Directors authorized the repurchase of up to 10% (or approximately 516,000 shares), of the Company's outstanding common shares from time to time. Shares repurchased under this Program may be held in treasury, retired, or used for general corporate purposes. As of June 30, 2002, the Company had repurchased no shares under this Program. The repurchase of shares under a previous stock repurchase program was completed in March 2002. At March 31, 2002, the Company had acquisitions pending for three insurance agencies, Blake Insurance Agency, Sise Insurance and Sise Financial Services, all located in Portsmouth, New Hampshire. The full service agencies offer complete lines of personal and commercial property and casualty insurance products, group benefits, individual life and disability coverage, annuities and other financial service products. At the time of the acquisition, 20 the combined agencies had annual premium volume of approximately $23,000,000. The combined agencies revenues are represented by commission income, which is based upon percentages of premium volume billed. These acquisitions provide for the Company's entrance into the insurance business. Further expansion in this area is anticipated. Effective April 1, 2002, the Company completed the acquisitions of these agencies. The acquisitions were accounted for using the purchase method of accounting and results of operations of the acquired insurance agencies have been reflected in earnings commencing April 1, 2002. The total purchase price for the three insurance agencies including transaction costs of approximately $100,000 was approximately $4,800,000 and included payments of approximately $4,500,000 in cash and the issuance out of treasury of 11,259 shares of Company common stock. The acquisition was allocated as follows:

The total consideration for the acquisition included cash paid net of cash acquired of $4,165,000 and the issuance out of treasury of 11,259 shares of Granite State Bankshares, Inc. common stock. The agency customer renewal lists are being amortized on the straight line method over ten years. Consolidated Quarterly Average Balances and Interest Rates The table on the following page presents, for the periods indicated, average balances of assets and liabilities, as well as yields on interest earning assets and the cost of interest bearing liabilities. 21 Granite State Bankshares, Inc. and Subsidiary Consolidated Quarterly Average Balances and Interest Rates ($ in Thousands)

22 Granite State Bankshares, Inc. and Subsidiary Part I Item 3 and Part II - Other Information June 30, 2002 Item 3. Quantitative and Qualitative Disclosures About Market Risk There has been no material changes in the Company's assessment of its sensitivity to market risk since its presentation in the 2001 annual report filed with the SEC. Part II -Other Information Item 1. Legal Proceedings The Company is a defendant in ordinary and routine pending legal actions incident to its business, none of which is believed by management to be material to the financial condition of the Company. Item 2. Changes in Securities None. Item 3. Defaults upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders On April 9, 2002, the Company held its Annual Meeting of Stockholders. The matters which were submitted to a vote of the security holders and the results of the voting at such meeting were as follows.

23 Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K 1. Exhibits Exhibit 99.1 Certification of Periodic Report 2. Reports on Form 8-K None. 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GRANITE STATE BANKSHARES, INC. /s/ Charles W. Smith ----------------------------------- Dated: August 12, 2002 By: Charles W. Smith Chairman and Chief Executive Officer /s/ William G. Pike ----------------------------------- Dated: August 12, 2002 By: William G. Pike Executive Vice President and Chief Financial Officer 25

GRANITE STATE BANKSHARES INC 10-Q